Ajay Srivastava on why he swears by PSUs and largecap stocks

We will continue to see only 15-20 stocks performing well over the next 6-12 months, says Ajay Srivastava, CEO, Dimensions Corporate Finance. Excerpts from his interview with ETNOW.

The bulls are not running but the bulls are limping in India. Globally, the bulls are roaring, US markets are at a record high, emerging markets are moving high irrespective of what is happening in the world. After a massive underperformance in June, are Indian markets on course to catch up with global markets in the month of July?

I do not think so. Two or three factors in our favour are lower interest costs, rupee dollar, oil prices. The reason I am less optimistic is not because of economic reasons but for the fact that our policies are moving greater and greater towards socialism. We seem to have fed a monster. The lower the economic growth, the more the need of doles and free sops. The more the doles and free sops come in the budget and from extra budgetary sources, more the growth slips. We are in a very vicious cycle of a socialism and I do not know how it will be ever broken. But the way it is running around, the growth is at 3% to 4% or 5%.

They will need more sops in the market and if the budget comes up with more sops and we are talking of PM Kisan going up to 8000 these free medical care being expanded etc. etc. I think it is people not understanding this is a vicious cycle killing growth in the country and if it is not broken it is going to get worse and worse. If it was not for global equity flows, we are like any other country like Greece for instance a couple of years back. We are like the UK when Margaret Thatcher came in when everything was being given out as doles and free sops and the capital market was close to a standstill. We are reaching that point where 80% of a budget is paying pensions, salaries, subsidies etc.. There is nothing else left in the Union budget. This shift towards socialism is what is bothering us as an equity investor.

Democrats in the US should pay heed to the example of what is happening in India, that the kind of scheme they are talking about is what India is doing right now and see that dramatically different result. The US is booming and we are struggling.

We have seen concerns with respect to the systematic risk from the NBFC crisis. The GDP growth is moderating quite significantly. Is that a major threat to the projected earnings as well for the financial year?
Let me put it this way. The answer is not very clear and the reason I say so is that it is not true for the whole economy. Some companies have monopoly like in aluminium industry. There is nothing else you can do. The companies have a monopoly and they will make their money whichever way they want. Problem comes in companies where there is a market distribution between small caps, midcaps, and large caps. There you see very clearly that the large caps are outscoring the small and midcaps. Where there are only large caps, the earnings are getting diluted. You need to make a distinction the industry structure as well to see what is happening to the economy. So, the NBFC crisis will affect not more on the earnings side but will affect more on the capex side. This is because promoters are borrowing money to put capex, to push new companies, launch new ventures etc. Everybody wants to repay debt.

The NBFC crisis is hitting us in a different way. It is hitting the consumption basket which was less than optimal prime customers. It is hitting us on the promoter funding side. For instance, there is no shortage of housing loans. But can one or two companies like Bajaj Finance and HDFC provide funding for a country of the size of India alone? But the fact is money is available. The problem is that people who were investing for growth and new ventures and companies are not able to access funding.

NBFCs have a little bit of different tilt now as source of available promoter funding dries down. So, new ventures will further come down. The only mitigant is as I said, look at what is happening down south, look at the private capital. That space is booming absolutely and so you have on one side, the capital market and the other side, you have a private equity space. There is funding available in this market, Listed stocks will be in trouble because they are more earnings than growth denominated. The south India based companies do not have a problem finding funding because they are equity driven companies. So, the NBFC crisis is going to affect us in the longer run not necessarily just in the short run.

The market is getting very polarised and rewarding only 10-15-25 stocks. Flows out of equity markets will not go away in a hurry because globally there is abundant liquidity. Locally real estate and gold is not doing well. So constant money will keep on coming to equity as an asset class. Would we go through this patch for another six, 12 months where only 15-20 stocks will outperform?
Absolutely. It is irritating at times because all the alpha fund managers want to find the missing gem in the market and all we end up doing at the end of the year is finding that all the missing gems hurt us more than what is on the table. But the critical question is are these 10-15 companies a safe bet? Of course, governance is an issue, you just saw what happened to Cox & Kings. The big issue for the market is not the returns, it is capital preservation. You have seen what happened to Eros Media, PCJ. Jet Airways, I would put in a different category altogether. The capital value of investors decimated 90%-95%! In that background, where do you go with your money?

Second, the way our policies are, whether we like it or not, HDFC stands out alone as the HFC of the nation. So you will be dumb not to buy the stock. If you do not have it in your portfolio, you will be dumb not to buy HDFC and HDFC Bank.

But can they carry an economy through, that is the question we have, but that is not for an investor to debate because that is for the government to worry about. I would still say outperformance will continue. The only difference that we are seeing in the market is that there is a sub bracket of Rs 1,000-2,000 crore kind of companies which are picking up. For example, SRF, DCM Shriram have started giving returns to the shareholders. So

Now, we are seeing another subset of companies with Rs 2,000-3,000 crore turnover who are giving a decent return at least to the investors. Should we buy these? Obviously we need to buy these because this is the economy! Will they continue to outperform? The answer is yes they will continue to outperform.

You may not like it but that is the reality and why fight what is on the table? It is money on the table.

What is happening with the Zee Group? A report that has come out talks about how the promoter leverage issues seem to be the biggest overhang, There is a sharp spike in the inventory and receivables on an year-on-year basis and now the promoter stake sale announcement is going to be the key catalyst. What do you think is going to happen with the stake sale?
Zee can be looked at in two ways; one is, fundamentally Zee is good, promoters have leveraged. The other way to look at it is from the corporate governance angle. I am not talking of Zee alone. Generally we have seen what happened to Eveready on Friday, the auditor just walked away after taking money for so many years. That is absolutely ridiculous and they should be brought to book.

So what is going on in the financials of these companies, puts into doubt whether you want to put capital behind such companies. I do not know what the receivables are and if they are in the related or indirectly related companies; which are these companies; what is the agency agreement. We saw the decimation in Sun Pharma, you saw what is happening in Emami.

When it comes to survival, I do not think promoters will lose their company as opposed to losing their personal assets. They will compromise companies, they will take out cash flows and we will see more of that repeating. I am not saying Zee will do that but I am saying generally as an investor that one should put a Chinese wall between the promoter and their companies of such kind of companies where there is such a close interaction. So it is a difficult call but I would still say stay away. Why are we risking ourselves by going into these kind of companies where auditors may walk away tomorrow and you have a 30% fall in the stock price? It does not matter, fundamentals do not matter, reality does not matter. Perception is these companies are not good for investment. So, why do it?

In light of all of this and in light of what we have been talking about and how we are comparing ourselves to the rest of the globe, where does that valuation seem to be attractive?
We are a very anti government group but strangely enough we have loaded ourselves very heavily with PSU stocks at this point of time -- be it power sector, mining sector, we have got it in our portfolios. Almost 40% of our portfolios are now full of PSU stocks for three reasons; one of course, I love the dividend yield Two, they are very well valued and are mostly monopolies including OMCs. Three, we are reaching a point where the government will have no choice but to follow what happened in the UK during Thatcher and privatise these companies. They have tremendous value. You cannot go wrong at 0.9 to 1.5 times book value with monopolies, real estate assets, cash on the bank, no capex literally in the pipeline and dividend.

PSU stocks is one place where we have parked a lot of our funds at this point of time. Our portfolio has become very simple; 40% large caps, 40% PSU, 20% are stocks which we had. We used to have fund managers for midcaps who are no more with us but we are trying to extricate ourselves out of those portfolios. So that is a rough distribution, 40, 40, 20. And gold has done well. Mother was always right. Gold is a good friend, not equity.

But if I had listened to my mother 10 years ago I would not have really made serious money, Nifty is giving me better returns.
But if you look at our parents portfolios, they had in their portfolios Smithkline Beecham, Hindustan Lever kind of stocks, they never had a midcap stock in their portfolio.